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Telstra overhaul the jolt it needed, says Morningstar

Emma Rapaport  |  20 Jun 2018Text size  Decrease  Increase  |  
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Telstra telecommunications article telco Andy Penn

Morningstar has cautiously welcomed Telstra’s (ASX: TLS) much touted strategy update, dubbing it the “jolt into action” the company needed as it battles to ward off rising competition and streamline bloated operations. 

Morningstar senior equity analyst Brian Han maintained a fair value rating on Australia’s oldest and largest telco, saying CEO Andy Penn’s "simplification" drive went some way towards winning more customers and improving efficiency.

“We maintain our $4.40 fair value estimate on narrow moat-rated Telstra, in the face of a plethora of ‘big bang’ initiatives and financial guidance unveiled,” Han said. 

The embattled telco made a fresh bid to win over investors and reassert itself as the dominant market player at the highly anticipated “Strategy Update” in Sydney this morning.

The announcement will see the birth of a streamlined Telstra, driven by improvements to customer experience, a simplified business structure via the creation of a separate wholly owned infrastructure unit, and the monetisation of up to $2 billion in assets over the next two years.

Under the revamp, Telstra plans to split into two units – MobileCo and the newly created InfraCo. This will oversee Telstra's fixed network infrastructure including data centres, non-mobile related domestic fibre, copper HFC, international subsea cables, exchanges, poles, ducts and pipes.

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The company will also expand its cost-cutting program by $1 billion, bringing the total savings to $2.5 billion by financial year 2022.

Telstra chief executive Andrew Penn told investors at this morning’s briefing the company was at a "tipping point" and must act now to disrupt and lead or fall behind as the industry undergoes rapid transformation.

"The rate and pace of change in our industry is increasingly driven by technological innovation and competition," he said.

"In this environment, traditional companies that do not respond are most at risk. We are now at a tipping point where we must act more boldly if we are to continue to be the nation's leading communications company."

As a part of its so-called Telstra2022 strategy, the company will cut 8000 jobs, with one in four executive and middle management positions disappearing over the next three years. Penn defended the job cuts saying that an "agile" structure is needed to deal for the company to deal with rapid technological innovation.

Han described the $1 billion lift in core fixed cost-cut target as “bold but necessary” given Telstra's “byzantine mess of legacy systems and processes”, and the “excess people employed to manage those systems.” He also cast doubt over the decision to create a standalone infrastructure unit, describing the split as largely “cosmetic”.

“Management’s reasoning that the split will ‘better optimise and manage these assets’ begs the question how these infrastructure assets have been managed to-date, and how a cosmetic split would change anything except create more complexity and hierarchy.

"In our view, management already has a lot on its plate to deliver on the cost cuts and cultural transformation promises.

“A split of Telstra into a MobileCo and an InfraCo strikes us as an external advisory/investment bank-led sophistry which has the potential to dilute management focus on more important matters at hand," says Han.

Telstra management reaffirmed the company’s 22 per cent per share dividend for financial year 2018 but said that it would update the market on the expected payment for financial year 2019.

Morningstar analysts have maintained their $4.40 fair value estimate on narrow moat-rated Telstra but note that this estimate "depends on an unrelenting focus on these important matters such as cost-cuts, simplification, digitisation."

Shares plummet despite cost-cutting

Investors baulked at the overhaul and the weak fiscal 2019 earnings guidance, forcing an intraday share plunge of 7 per cent.

Telstra stock hit lows of $2.70 at 10:26 AEST – its lowest level since 2011 – and closed at $2.77.

Telstra last month warned its 2017/18 earnings would likely be at the bottom of its guidance range of $10.1 billion to $10.6 billion, blaming increasing competition in mobile and fixed broadband, and rising costs from the National Broadband Network.

Buried deep in today's announcement, Penn revealed that he expects the trends to continue in to financial year 2019, with a 2 to 3 per cent decline in mobile and fixed revenue.

Telstra is now anticipating earnings before interest, tax, depreciation and amortisation (EBITDA) of between $8.7 billion to $9.4 billion in fiscal year 2019, before restructuring costs of about $600 million.

Morningstar analysts had expected EBITDA to sit at about $10.4 billion in fiscal year 2019.

Han says the earnings downgrade hurts, especially at a time when the market is still smarting over the fiscal 2018 earnings downgrade last month. However, he sees the company’s proposed revamp as going some way to ensuring its competitive advantage, as a new player enters the mobile market.

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Emma Rapaport is a reporter for Morningstar Australia.

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

is the editorial manager for Morningstar Australia. Connect with Emma on Twitter @rap_reports. You can email Morningstar's editorial team editorialAU[at]morningstar[dot]com

© 2021 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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